When European Union leaders embarked on a two-day summit in Brussels last week to adopt a comprehensive strategy for stabilizing the Eurozone, it was clear that the EU is still under the grip of a sovereign debt crisis, now emanating from the economically — and politically — fragile Iberian peninsula.
Portugal’s Prime Minister, Jose Socrates, resigned on Wednesday after Parliament rejected his proposed austerity budget, further damaging the country’s already indebted economy. European officials and financial analysts acknowledged that it is now increasingly likely that Portugal will have to turn to the European Financial Stability Fund for a bailout similar to those enacted for Greece and Ireland last year.
Following a downgrade on Portugal’s credit rating by Standard and Poor today from A- to BBB, yields on Portuguese benchmark ten-year bonds jumped dramatically to nearly 7.9 percent, a level economists agree is entirely unsustainable in the long-term.
However, the ripple effect throughout the rest of the Eurozone has so far been “limited,” says Gilles Moec, an analyst at Deutsche Bank. “It seems that market reaction is subdued. There is no sign of contagion to Spain, which is the obvious next country in line,” he says. Moec argues that as long as Spanish markets — particularly the banking sector — remain relatively stable, the crisis in Portugal will be contained.
Nonetheless, Portugal’s back is against the wall. The country is required to refinance €4.5 billion of sovereign debt by next month — the driving factor behind the increased taxes and austerity measures put forward by Socrates. The Prime Minister, who will remain in charge of a caretaker government until elections are held in May or June, is determined not to request outside assistance. But many analysts think that the pressure on Portugal to make bond repayments in April could force the government’s hand prior to the elections.
“It is hardly likely that Portugal will manage without external support up to the new elections...The Portuguese Finance Minister will probably not be able to borrow these funds [for the bond repayments] at acceptable conditions on the capital market,” Christophe Weil, an analyst at Commerzbank, writes in a March 25 report on Portugal.
Moec concurs that Portugal will need external support to meet its refinancing requirement in April. But, in the absence of a clear government mandate requesting a bailout, he believes that the initial support will most likely come from the European Central Bank. “It’s not elegant, but it might be the only way to insure bridge financing to keep [Portugal afloat] before the country will eventually request a bailout,” Moec says.
Meanwhile, at the summit last week, European leaders agreed to extend the European Financial Stability Fund (EFSF), and establish a permanent European Stability Mechanism (ESM) by 2013. According to Antonia Mochan, a spokesperson for the European Commission, “The ‘operational features’ of the permanent Stability Mechanism were confirmed and the Council will make sure that €500 billion is available with triple-A status. It was also agreed to ensure that the temporary Facility [EFSF] has an effective lending capacity of €440 billion. It will be in place in June.”
Even without the new EU agreements, the lending capacity of the EFSF is currently at €250 billion, more than enough to fund a Portuguese bailout that is estimated will be anywhere between €60 to €80 billion.
The larger issue for Portugal — which has had sluggish GDP growth for a decade, and a Current Account Deficit that is 10 percent of its GDP — will be whether its wealthier northern neighbors have the political will to authorize such a bailout. Finland, for one, currently in the throes of an election season, is on the fence. In a March 24 report on the situation, Moec explains, “Unanimity is required across EFSF’s stakeholders to trigger the support [bailout], and government parties in Finland are under pressure from a euro-skeptic populist party to reject additional commitments.”
While Commerzbank’s Weil notes in his report, “With the current rescue mechanism, support to Portugal is difficult to achieve. The IMF especially will insist on a harsh savings program.”
“But,” Weil concludes, “the past has shown that politics will find a way. The Eurozone is on its way to becoming a transfer union.”
